Contents

Structured Finance

Watching waterfalls

Call for increased derivatives disclosure in securitisations

A first step towards creating a safe and transparent ABS market in Europe, in line with recent ECB rhetoric, could be greater scrutiny of cashflow waterfalls. A list of items that securitisation issuers should disclose has been put forward to facilitate such scrutiny.

"Derivatives contracts at the top of cashflow waterfalls mean that most securitisations, in their current form, are not transparent and potentially not safe," says ex-Moody's svp William Harrington. "Cross-currency swaps in European transactions are of particular concern because they show the most volatility and market risk of any 'plain vanilla' derivative and have already caused blow-ups, as seen with the Eurosail programme."

The debate about a safe and transparent ABS market should centre on the sound assessment of derivatives exposure, according to Harrington. "There is generally little-to-no information on the derivatives embedded in securitisations. Given that swaps sit at the top of cashflow waterfalls, interest and principal payments are at ongoing risk from counterparty insolvency."

He continues: "Moreover, counterparty exposure is highly concentrated; insolvency of a single counterparty would impact many, many ABS at the same time. Investors should therefore be provided with all the information necessary to assess counterparty risk and the likelihood of being repaid."

To help size a securitisation's obligations and expenses that are additional to those associated with the underlying asset pool, Harrington suggests that issuers should disclose information on derivative contracts at deal origination and update the information at subsequent reporting dates for so long as the derivatives are outstanding. He puts forward 13 such disclosure items, which should be costless for an issuer to compile and release: the type of derivative contract; notional amount of contract; legal final maturity of contract; upfront payment paid or received by ABS issuer; counterparty to contract; guarantor of counterparty to contract; mark-to-market of contract on counterparty books and records; collateral posted by counterparty to issuer; presence of flip clause in contract or in priority of payments; provisions that enable a counterparty to modify the contract without obtaining consent of ABS investors; RAC provisions obtained to-date; previous counterparties to contract; and previous guarantor of counterparty to contract.

"A sophisticated institutional investor or valuation specialist can form an independent assessment of a securitisation's exposure to counterparty insolvency with these disclosures. Such information would force investors to think about and analyse additional risks that may not be immediately obvious," Harrington observes.

He adds that 'safe and transparent' ABS should be more expensive to issue because they should be based on accurate pricing, which compensates investors appropriately for derivatives risk. "The price would depend on the mismatch between the reference index of the pool and the reference index of the placed liabilities, as well as overcollateralisation levels that mitigate the mismatch. Transactions should be more expensive if two currencies are involved, less expensive if it's the same currency but the assets are fixed rate and the notes are floating rate, and even less expensive if it's the same currency and the assets and notes are both floating rate but are tied to different reference indices."

Even more robust structures could have equity that benefits from what Harrington describes as a self-hedging mechanism: if the overcollateralisation buffer is not needed by maturity, the equity holders would receive a boost in yield. "This would involve taking a view on where the reference indices are likely to move," he says.

Such differentiation of risk could, in turn, create a more rational borrowing and investment landscape - with the cost to the borrower reflecting investor appetite for exposure to volatility in reference indices, such as currencies or interest rates, as well as to borrower credit. Harrington concedes that this is likely to make credit more expensive and preclude some borrowers from access to credit, but suggests that those in genuine need could be subsidised by a separate public mechanism.

In a move that may see securitisations using swaps less often, ABN AMRO yesterday priced the €770m Arena NHG 2014-I for sponsor Delta Lloyd. To create a more efficient transaction with less counterparty dependency, rather than a typical interest rate swap, the Dutch RMBS features a cap agreement covering the floating-rate €119m class A1 and €286m class A2 notes until the April 2019 step-up date, and a cap embedded in the terms and conditions of the notes thereafter. The capital structure also includes a €280m fixed-rate class A3 tranche.

The triple-A rated (Fitch and Moody's) senior notes were placed externally with what ABN AMRO describes as "a select group of key investors".

"The main rationale for excluding a swap is the increasingly stringent Basel 3 and Solvency regulations," explains Matthijs van der Horst, head of debt syndicate at ABN AMRO. "These lead to increasing costs resulting from liquidity and capital requirements, as well as increased volatility of potential collateral postings for these swaps. We believe the structure of this transaction may well become an industry benchmark."

As hedge counterparty, ABN AMRO will pay on a quarterly basis any excess of three-month Euribor above 3.5% multiplied by the cap notional. As of the step-up date, all class A notes switch to one-month Euribor floating (including the class A3 notes). If one-month Euribor exceeds 5%, the excess amount - including the step-up margin - will be subordinated in the interest priority of payments.

Given the lack of an interest rate swap, Moody's notes that the portfolio's 4.6% asset yield can be affected by two main uncertainties: adverse prepayments of loans with higher interest rates; and the rate to which the loans can reset at the next interest reset date. Further, the cap notional will reduce over time based on 4% total annual amortisation of the mortgage portfolio. Additional interest rate mismatch risk could arise if the actual amortisation of the mortgage pool is less than the reduction of cap notional.

Based on its analysis of a number of interest rate scenarios, Moody's indicates that the amortisation of cap notional in excess of portfolio amortisation during the pre-step-up period may cause an interest rate mismatch when three-month Euribor is above 3.5%. "However, in our view based on analysis of historical prepayments of comparable deals and interest rate scenarios, this risk is sufficiently low," the agency observes. "By comparison, during the most recent financial downturn the five-year average constant prepayment rate for Arena and Darts transactions was approximately 5.3% and 5.5% respectively. The scheduled principal payments for this pool are approximately 1% per annum until step-up date."

Given the regulatory push to facilitate SME lending in Europe, Harrington believes that the ECB should roll out a pilot securitisation programme that eliminates the front-loaded payments associated with the existing model. "ABS vendors - such as underwriters, counsel, rating agencies and accountants - are paid from issuer proceeds at closing. Trustees and rating agencies are also paid at senior positions in a waterfall on an ongoing basis," he explains.

Harrington adds that there is yet to be an intelligent bottom-up evaluation of how to promote credit via ABS, but notes that many perceived stumbling blocks could be resolved with better information. "One way of achieving this would be to release a template to the market and let participants rip it apart," he concludes.

CS

Structured Finance

SCI Start the Week - 18 August

A look at the major activity in structured finance over the past seven days

Pipeline
Only a handful of deals joined the pipeline last week amid the summer lull. Of these transactions, two were CMBS - US$355m BBCMS 2014-BXO and AYR Issuer. The other newly announced deals were US$285.69m Macquarie Equipment Funding Trust 2014-A (an ABS) and US$350m Monroe Capital CLO 2014-1 (a CLO).

Pricings
ABS accounted for the majority of pricings last week. A couple of CLOs, CMBS and RMBS also printed during the week.

The ABS new issues comprised: US$1.4bn Applebee's Funding/IHOP Funding Series 2014-1, US$1bn Honda Auto Receivables 2014-3 Owner Trust, US$250m Miramax Film Library Securitization 2014-1, US$501.5m South Carolina Student Loan Corporation (1996 Indenture) 2014 Series, US$253.55m Susquehanna Auto Receivables Trust 2014-1, NZ$283.25m Q Card Trust and US$1.25bn Volkswagen Credit Auto Owner Master Trust Series 2014-1. The CLO pricings included US$415mn Arrowpoint 2014-3 and the refinanced US$350.75m Race Point VI CLO, while the US$1bn BHMS 2014-ATLS and US$1.9bn COMM 2014-CCRE19 accounted for the CMBS prints. Finally, US$229m Morgan Stanley Residential Mortgage Loan Trust 2014-1 and US$342.67m ARP 2014-SFR1 rounded out the issuance.

Markets
US non-agency RMBS cash prices remained stable last week, although trading activity moderated, with daily volumes averaging less than a billion dollars. Notably GSE risk transfer bonds reversed 20bp-30bp of the past few weeks' widening.

US CMBS spreads also appear to be stabilising after a sharp sell-off the week before last. 2007 duper last-cashflow and AJ bonds were unchanged at swaps plus 84bp and plus 477bp respectively. Barclays Capital CMBS analysts note that secondary trading volumes were down, with US$1.4bn in bid-lists circulating, compared with US$2bn the previous week.

Meanwhile, agency CMBS spreads widened last week, after holding up better than conduit CMBS the previous week. Freddie K senior A2 tranches widened by 5bp to swaps plus 40bp, while Fannie DUS loans widened by 6bp to plus 48bp.

US ABS secondary spreads generically moved 1bp-2bp higher across the traditional triple-A sectors, with trading volumes also lower week on week. An average of US$1.16bn of ABS traded during the first four days of the week, compared with US$1.27bn over the same timeframe the previous week.

Similarly, secondary US CLO activity dialled down last week, with BWIC volumes totalling only about US$250m. "CLO 1.0 deals continued to see strong bids, as they roll down the curve. CLO 2.0 and 3.0 deals, on the other hand, saw some softness - especially among mezzanine tranches - following the weakness in the leveraged loan market over the past couple of weeks," Bank of America Merrill Lynch CLO strategists observe.

Overall US CLO 1.0 spreads remained unchanged from the previous week's levels, while 2.0 and 3.0 double-A and single-A spreads widened by 15bp to about 230 and 330 DMs respectively.

Activity was also low in the European CLO secondary market, with around €50m appearing on BWIC lists - mainly composed of items lower in the capital structure. Some CLO 2.0 double-B bonds traded within a range of around 610bp-630bp, while a few late-vintage legacy equity line items traded broadly in line with expectations at IRRs of around 10%.

Deal news
• The FHFA has released a request for input on the proposed structure for a single security that would be issued and guaranteed by Fannie Mae or Freddie Mac. The initiative aims to improve the overall liquidity of GSE MBS by creating a single security that is eligible for trading in the TBA market.
• With FN 4.5s prices nearing their all-time highs, the US agency RMBS sector appears to be at a tipping point from a rates perspective. So far, mortgage production and refinancing concerns have remained well contained, but market dynamics could change if rates rally by another 25bp.
• Private RMBS has traditionally only constituted a small part of Canadian residential mortgage funding. However, with the dominant government-backed RMBS programme being scaled back, the sector has room to grow.
• The US$6.2m Langtree Ventures Portfolio loan - securitised in GSMS 2013-GCJ14 - has been resolved with a 1% loss severity, becoming the second-ever CMBS 2.0 loan to liquidate. The payment distribution was consistent with the CMBS 2.0 waterfall, in contrast to the first 2.0 liquidation - The Cove at Southern, securitised in JPMCC 2011-C5 - which resulted in a surprising interest shortfall reimbursement to the class NR notes (see SCI's CMBS loan events database).
• The US$50m Ridgeview Apartments loan - securitised in DBUBS 2011-LC2A - was fully defeased in June, but workout fees continue to accrue. This is said to be due to a prior technical modification.
• The average US CLO triple-A spread for transactions rated in July 2014 was 1.51%, similar to the average triple-A spread for 2012 vintage transactions that are currently exiting their non-call periods. Although current triple-A spreads would appear to limit opportunities for CLO refinancing, rating agencies are receiving a steady stream of such requests.
• The lending environment remains strong for CRE and take-out activity continues to be seen in CMBS 2.0 collateral. Some early payoffs are taking place shortly after expiration of the lock-out period, with borrowers paying the premium of yield maintenance to take advantage of the persistent low interest rate environment.
• Around 85% of rating changes for European CLOs so far this year have been upgrades. The positive rating trend has been in force since 2011 and means that many tranches are now at or close to their original ratings once more, particularly at the top of the capital structure.
• Fitch has downgraded 10 and affirmed three tranches from three BBVA RMBS deals, after it found that the volume of distressed loans in the underlying portfolios was understated in the regular reporting for the transactions. The notes were placed on rating watch negative in May, pending analysis of the information provided by the management company Europea de Titulizacion.
• The controlling class of Cedarwoods CRE CDO II is proposing to replace Angelo Gordon with Torchlight affiliate Collateral Management as collateral manager. Moody's has determined that the proposed collateral management assignment and assumption will not impact the current ratings of the notes.
• An auction has been scheduled for RFC CDO II on 29 August. The securities shall only be sold if the proceeds are greater than or equal to the auction call redemption amount.

Regulatory update
• Under the latest revisions to Solvency 2, capital charges for type 1 securitisation positions rated double-A, single-A and triple-B are set to be reduced by 29%, 46% and 41% respectively. The changes appear to be targeted at the issuance of securitisations backed by residential mortgages, consumer loans and particularly SME lending from southern European countries that cannot achieve triple-A ratings and were disproportionately disadvantaged by the previous capital charges.
• Santander Consumer USA disclosed in its latest 10-Q filing that it has been issued a civil subpoena by the US Department of Justice requesting documents relating to the underwriting and securitisation of non-prime auto loans since 2007. Based on what has been announced so far, increased regulatory scrutiny is not expected to represent a major risk to the credit fundamentals of outstanding subprime auto ABS deals.
• The focus of US financial crisis-related litigation activity is turning towards the trustee community. The fundamental issue at stake in this new breed of dispute is who's going to pay.
• SEBI has released for comment a concept paper regarding the introduction of a standardised term sheet for securitisation transactions. The aim is to rationalise, clarify and enhance various aspects of the Indian market, such as eligibility criteria, roles and responsibilities associated with securitisation trustees.
• The US Fed, the OCC and the FDIC have warned that banks found to have unsound practices - based on leveraged lending guidance released in 2013 - could be subject to enforcement actions. Such actions are expected to have a mixed impact on CLO investors.

Deals added to the SCI New Issuance database last week:
Atrium VII (refinancing), Avoca CLO XII, CarMax Auto Owner Trust 2014-3, CIFC Funding 2012-1 (refinancing), CIFC Funding 2014-IV, Cronos Containers Program I Series 2014-1, Enterprise Fleet Financing Series 2014-2, First Investors Auto Owner Trust 2014-2, GSMS 2014-GSFL, Invitation Homes 2014-SFR² Trust, JPMBB 2014-C22, KKR CLO 9, Navient Student Loan Trust 2014-2, Navient Student Loan Trust 2014-3, Navient Student Loan Trust 2014-4, Navient Student Loan Trust 2014-5, Navient Student Loan Trust 2014-6, Navient Student Loan Trust 2014-7, NYCTL 2014-A Trust, Oaktree EIF II Series A1, OFSI Fund VII, Orange Lake Timeshare Trust 2014-A, OZLM VIII, Silver Spring CLO, Silver Bay Realty 2014-1 Trust, SMB Private Education Loan Trust 2014-A, St Paul's CLO V, THL Credit Wind River 2014-2, 2014 Popolare Bari SME CLO and Toro European CLO 1.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2008-1, BSCMS 2006-PW14, CD 2006-CD3, CD 2007-CD4, Cedarwoods CRE CDO II, CMLT 2008-LS1, DBUBS 2011-LC2, DECO 2006-E4, ECLIP 2006-2, ECLIP 2007-1, ECLIP 2007-2, EURO 23, EURO 25, EURO 28, JPMCC 2005-LDP1, JPMCC 2006-CB14, GCCFC 2006-GG7, GSMS 2006-GG6, GSMS 2007-GG10, GSMS 2012-GCJ7, GSMS 2013-GCJ14, LBUBS 2006-C1, MESDG CHAR, MLCFC 2007-7, MLCFC 2007-9, MLMT 2005-CIP1, MSC 2005-T1, TAURS 2006-3, TAURS 2007-1, TITN 2007-1, TMAN 5, TMAN 7, WINDM VIII, WBCMT 2007-C32 and WFRBS 2012-C8.

Structured Finance

Servicer advances 'attractive' despite headline risk

Ocwen and HLSS last week announced that they will restate their financial statements for 2013 and 1Q14 and delay filing their second-quarter 10-Qs until the revisions have been completed. The move is due to a change in how Ocwen accounts for the valuation of 'rights to MSRs' that it had earlier sold to HLSS, according to Barclays Capital RMBS analysts.

"In particular, Ocwen and HLSS determined that the receivables should be accounted for at the best available estimate of fair value, in accordance with GAAP standards - instead of being accounted for under a plus/minus 5% range of estimated fair values, as was their previous practice," they explains. "The accounting change is expected to result in an increase in 2013 pre-tax income of US$17m for Ocwen and a reduction in its pre-tax income in 1Q14 by the same amount. The companies do not expect any material changes in their operating conditions as a result of the accounting restatements."

The earnings restatement follows news that New York Department of Financial Services superintendent Benjamin Lawsky has asked Ocwen's general counsel to explain the forced-place insurance arrangements made between Ocwen and one of its related companies Altisource. The NYDFS appears to be concerned about Altisource's role in designing a forced-place insurance programme for Ocwen and the commissions it may have received from the arrangement.

Moody's has placed Ocwen's and HLSS' corporate family ratings (B1 and Ba3 respectively) on review for a possible downgrade as a result of the regulatory scrutiny and earnings restatements. The Barcap analysts do not believe that either a corporate ratings downgrade or the delay in HLSS' 10-Q filing will result in any triggers on outstanding HLSS servicer advance securitisations at this time.

"Even if a delay in HLSS' financial filing is considered a breach of the master servicer's covenants under the designated servicing agreements of the advance receivables (which is debateable), there is a 30-day cure period associated with any breach. Furthermore, corporate ratings downgrades are not considered either early amortisation or target amortisation triggers, nor are they considered servicer termination events under the indenture. Instead, servicer advance deals are specifically concerned with servicer ratings, not corporate ratings," they observe.

While a downgrade of Ocwen's subprime servicer rating to below average would reduce the advance rates applied against each of the receivables in the trust by an additional five percentage points, Ocwen's subprime servicer rating is currently above average (negative outlook) and, as such, there is some cushion before the advance rates are reduced. Servicer termination events associated with a downgrade of the servicer rating are also explicitly excluded from being considered target amortisation events.

In a worst-case scenario, however, the analysts note that Ocwen could enter into early amortisation if it is unable to generate enough advance receivables to keep the ABS notes sufficiently collateralised or if enough RMBS investors in the underlying designated servicing agreements opt to replace HLSS/Ocwen as the master servicer of the related RMBS trusts - thereby converting the associated advances into ineligible receivables and eventually leading to an undercollateralisation event. Additionally, a facility early amortisation could result in the unlikely event that Ocwen or HLSS are sold to a third-party entity or become insolvent.

"Our view continues to be that servicer advance ABS remains attractive at current levels for investors who can withstand the headline risk and price volatility of the assets. We ultimately believe that the nature of the collateral (low-LTV receivables against residential properties) inherently provides significant protection against write-downs on the securities and will fully cover the notes, even if the deals were to enter into early amortisation," the analysts conclude.

CS

RMBS

Call likelihood gauged

US RMBS clean-up call activity picked up in 2Q14, with 10 deals called during the period versus six in the previous quarter. Together with lower rates, one factor that may be contributing to the up-tick is rising prices for non-performing/re-performing loans.

"If rates stay range-bound and NPL/RPL markets remain strong, call activity will likely stay elevated," Barclays Capital RMBS analysts suggest.

Recently called deals typically have higher coupons and lower delinquency rates. To evaluate deal economics at the call date, the Barcap analysts created a simple framework to compute the value of the collateral. The framework is divided into four stratifications - always current loans, previously delinquent loans that are over 24 months current, previously delinquent loans that are under 24 months current and delinquent loans - each of which is valued separately.

The value of always current loans is approximated by the price of a seasoned FNMA pool, with similar net WAC. The value of the second category loans is assumed to be 10 points back of the price of a seasoned FNMA pool with a similar net WAC. Finally, the values of the third and fourth categories are assumed to be about 86% and 72% of UPB respectively.

By applying the framework to CHASE 2003-S11 (a recently called deal), the analysts find that the approximate price for the collateral is just under US$106. Using the framework to approximate the collateral values of the 98 deals identified as being called since 2011, they find that the median deal was called at about US$106 collateral value, with very few of the transactions showing values below US$104-US$105.

Using US$106-US$108 as the threshold to identify deals that are likely to be called, the analysts suggest that the RMBS shelves with transactions showing above-average likelihood of being called include: RALI (2000-2002 and 2003-2004 vintages), RFMSI (2003-2004), GMACM (2003-2004), CWHL (2000-2002 and 2003-2004), CWALT (2003-2004), BOAMS 2003-2004), WFMS (2003-2004 and 2005-2007), PRIME (2003-2004) and WAMU (2003-2004). Further, the servicers that are most likely to call or have called many deals in the recent past are identified as ResCap, BoA/Countrywide and Wells Fargo.

Of the call-eligible deals outstanding, about half would be called under this framework if servicers call every deal above US$106. The number falls to about 17% for US$107 and 7% for US$108.

"We believe that given the relatively higher NPL/RPL prices today versus the past 2-3 years, we should expect the threshold level on this measure to fall over time and calls to become more likely if the lower rates environment persists," the analysts conclude.

CS

RMBS

Call for Fed MBS exclusion

The US fixed income indices commonly used by money managers exclude Fed Treasury holdings when calculating their composition but include its RMBS holdings. However, money managers would likely be overweight MBS rather than underweight if the Fed's RMBS holdings were also excluded.

The Fed's Treasury holdings have historically been excluded from fixed income indices. But after the Fed began buying agency MBS in its first round of quantitative easing, it was decided that these holdings would be included in index calculations - arguably on the assumption that the Fed would eventually sell its MBS holdings and that changing index methodologies might be disruptive to the broader market.

However, Citi agency MBS strategists point to three factors that present a strong argument for revisiting this decision: inconsistent criteria; the size of the Fed's MBS portfolio; and the longevity of its portfolio. "The fact that Treasury holdings of the Fed are excluded while MBS are included significantly skews the composition of fixed income indices and is not consistent. From the perspective of money managers, it makes sense to exclude all the holdings of the Fed from the index calculations as the Fed's purchases are based on monetary policy rather than the relative value across different assets," they observe.

Further, the Fed now owns 31% of outstanding agency MBS, compared to approximately 21% of the Treasury market. Thus, the stock effect of the Fed's purchases is more relevant in MBS than in Treasuries.

Finally, the Fed is expected to keep reinvesting MBS pay-downs until after the first rate hike. Based on Citi estimates, the Fed's ownership of MBS will remain at 30% through 2015.

"Indeed, an expanded balance sheet may be a long-term phenomena as the Fed contemplates holding on to Treasuries and MBS as an additional policy tool for monetary policy," the Citi strategists add.

To estimate the impact of excluding the Fed's MBS holdings from fixed income indices, they calculate Citi's BIG index under three scenarios: excluding the Fed's Treasury holdings but including its MBS holdings (the current composition criterion); excluding all the securities (MBS, Treasury and agency debt) held by the Fed; and including all of the securities held by the Fed. The findings show that if both the Fed's MBS and Treasury holdings are removed from the index, the allocation to mortgages reduces significantly from 29% to only 20%, while the Treasury allocation would increase to 42% (from 38%) and the investment grade credit allocation to 33% (from 29%). Based on this modified index, money managers would currently be overweight MBS rather than underweight.

Unsurprisingly, even if the index is calculated by including both the Fed's Treasury and MBS holdings, the MBS allocation is reduced to 25%. "Thus, if Treasuries and MBS are treated consistently, money managers would need to allocate a much smaller percentage of their holdings to MBS. Given that money managers are gauged on how they perform versus fixed income indices, the artificially higher allocation of MBS in the index forces money managers to buy the sector, even if spreads are rich," the strategists conclude.

CS

ABS

Alta Group adds ABS pro

The Alta Group has appointed Daryl Ching as md in Canada. He has more than 10 years of securitisation experience and was most recently at RBC Capital Markets, having previously worked at Coventree.

Structured Finance

Aviation attorney recruited

Vanessa Gage has joined Reed Smith as a partner in San Francisco, where she is a member of the firm's financial industry group. Gage was previously an attorney in Mayer Brown's New York office, where she focused her practice on asset-based lending, securitisation and other structured products. She is especially known for her work on major aviation and rail deals.

Structured Finance

SF legal vet joins Canada firm

Borden Ladner Gervais (BLG) has added Paul-Michael Rebus to its banking and financial services group in Toronto. He has broad structured finance experience across credit derivatives and securitisation.

Rebus joins BLG from Addleshaw Goddard, where he was a partner in the DCM, securitisation and structured products group in London. He has also worked at Eversheds where he was a partner in the structured finance group, at McDermott Will & Emery where he was group head for securitisation and structured finance and at Cadwalader Wickersham & Taft.

CDO

CRE CDO manager transfer proposed

The controlling class of Cedarwoods CRE CDO II is proposing to replace Angelo Gordon with Torchlight affiliate Collateral Management as collateral manager. Moody's has determined that the proposed collateral management assignment and assumption will not impact the current ratings of the notes.

For other recent CDO manager transfers, see SCI's database.

ABS

Auto lending examined

In its Q2 report on household debt and credit, the New York Fed finds that housing-related debt shrank, while non-housing debt balances increased across the board - with especially strong gains in auto loans. Auto loan balances - including leases - have increased for thirteen straight quarters and originations have not been this high since 3Q06.

Against the backdrop of widespread concern about the boom in subprime auto lending, the Fed points to a post it published last year, which showed that 23% of auto loans were originated by borrowers with credit scores below 620. This share is lower than the 25%-30% share seen during the years preceding the financial crisis. The report revisits these statistics and finds again that the share has increased only slightly since 2010.

However, the Fed adds that the small increase in the share masks the fact that the subprime auto lending market has grown substantially over the last several years. Since the trough in 4Q09, growth has been most pronounced among riskier borrowers, which also experienced the most severe contraction during the credit crunch of 2007-2009.

"The dollar value of originations to people with credit scores below 660 has roughly doubled since 2009, while originations for the other credit score groups increased by only about half. These gains in origination volumes reflect an increase in the average size of the loans more than an increase in the number of loans," the report observes.

Auto finance companies originated 53.7% of the new loan balances in 2Q14 and banks originated the remainder. Auto finance company lending to each of the three lowest credit score groups has more than doubled since the trough. In contrast, bank lending to subprime borrowers has historically been lower than the lending to prime borrowers and the share of subprime borrowers remains small.

The difference in risk appetite between banks and finance companies is reflected in delinquency rates, according to the report. While the quarterly flow into 30-day delinquency for bank loans has been about 1% in recent years, it was about 2.5% for loans by auto finance companies.

The Fed concludes that while subprime auto lending is on the rise in absolute terms, the increase in prime auto lending over the same period makes the relative increase in the subprime share less pronounced. "This resurgence in subprime loans is stronger among auto finance loans, where subprime lending is - and always has been - more prevalent than bank loans."

ABS

Punch seeking further support

Punch Taverns has announced that its restructuring proposals for the Punch A and Punch B securitisations have the support of a broad range of stakeholders, which in aggregate own or control around 65% of the notes and around 54% of the equity share capital of the pubco. However, implementation of the proposals is conditional upon the approval of shareholders, all classes of noteholders and other securitisation creditors - including RBS (as liquidity facility provider and hedge counterparty to Punch A), Lloyds (as liquidity facility provider), Citi (hedge counterparty to Punch B) and MBIA UK Insurance (the monoline insurer for Punch B).

Failure to obtain approval for the proposals from this group is expected to lead to near-term default in the Punch A and Punch B securitisations. Both transactions would be in default without the benefit of the current covenant waivers, which are conditional upon a restructuring being approved by all parties by 14 October.

Supporting stakeholders comprise the ABI Special Committee, together with investment funds managed or advised by Alchemy Special Opportunities, Avenue Europe International Management, Angelo Gordon, Bluecrest Capital Management, Glenview Capital Management, Luxor Capital Group, Moore Capital Management, Oaktree Capital Management, Seer Capital Management, Serengeti Asset Management, and Warwick Capital Partners. Ambac (the monoline insurer for Punch A) has also agreed to support the proposals.

The proposals were launched within the 10 business-day cure period for the 11 August milestone set out in the Punch A and Punch B covenant waivers, which were approved on 18 July. They are expected to reduce total net debt (including the mark-to-market on interest rate swaps) by £600m, with the consolidated net debt to EBITDA leverage ratio of the Punch Group falling to circa 7.7x. Gross securitisation debt of £1.585bn at closing will have an initial effective interest rate of circa 7.8%, including PIK interest.

In consideration for the debt reduction, the debt-for-equity swap and firm placing contemplated by the proposals would result in significant equity dilution for existing shareholders, such that Punch's currently issued share capital would represent 15% of its total enlarged issued share capital.

If all requisite approvals are obtained, the proposals are expected to become effective - and dealings in the new ordinary shares are expected to commence - on 8 October.

ABS

Subprime auto delinquencies moderating

Moody's does not expect US subprime auto loan losses to reach crisis levels. The agency explains that although delinquencies have risen over the last few years, they remain below the levels at the height of the financial crisis and have started to moderate.

"Subprime auto lenders have already started to rein in lending to weaker credit-quality borrowers," says Moody's svp Mack Caldwell. "Barring an imprudent expansion in lending to subprime borrowers, delinquencies will not increase to crisis levels."

Instead, the increase in lending to subprime auto customers marks the return to a typical consumer lending cycle, according to Moody's. In recent months, banks and other non-traditional lenders have started to pull back from lending to subprime borrowers, which has eased pressure on the smaller finance companies that traditionally finance subprime auto loans. With less competitive pressure, lenders can target higher credit-quality borrowers.

"Lenders have become more cautious, as evidenced by the rising credit scores of borrowers buying used vehicles," says Caldwell. "Subprime interest rates are also rising, a sign that lenders have a lower risk appetite."

Delinquencies have risen with each full origination year since 2010. The economic recovery and pent-up demand for autos spurred lenders to increase their loan volumes by extending credit to weaker borrowers. Competition among auto lenders increased to accommodate the pent-up demand, causing lenders to loosen underwriting standards.

"The potential for profits from subprime lending attracted banks, credit unions and captive finance companies, which typically do not focus heavily on subprime borrowers," says Moody's vp and senior analyst Peter McNally. "The average credit score on both used and new vehicle loans had declined and loan terms had lengthened, increasing the period in which a borrower could default."

Moody's continues to be concerned over the long term about the operational risk in ABS backed by subprime auto loans from smaller lenders, however. "Increasing origination levels for small, niche players strain their ability to manage loan and transaction cashflows if they do not also increase servicing capacity, which can ultimately lead to higher losses," cautions McNally. "Higher loan losses can cause a financially strapped lender to lose investor confidence and funding, increasing the securitisation's losses if the servicer fails and a servicing transfer disrupts collections and loss remediation efforts."

Structured Finance

Credit funds hit by redemptions

Hedge fund assets declined by 0.49% in July, according to eVestment, with performance accounting for the majority of the dip. Though positive for the seventh consecutive month at US$4.9bn, investor flows were below the last twelve-month inflow average of US$14.6bn.

The primary reason for muted net inflows in July appears to be redemptions from credit strategies, which saw US$2.4bn redeemed during the month. Directional credit and MBS-focused strategies were particular affected by outflows during the month.

Meanwhile, eVestment notes that investors continued to allocate into strategies focused on European markets in July, capturing opportunities in both European credit and equity markets. Inflows were US$2.4bn in July and have reached US$25bn so far in 2014.

Overall July's net inflow pushed year-to-date total net inflows above US$100bn - a level the industry has not seen since 2007. Total industry AUM now stands at US$3.017trn.

Structured Finance

Bond insurance value recognised

Bond insurance can have significant value, even when the bond insurer is rated the same or lower than the underlying rating on the wrapped bond, Fitch suggests. In the agency's view, the more important rating relationship is the relative difference between the bond insurer's rating and the underlying bond rating at the time the wrapped bond comes under stress.

"As long as the bond insurer remains financially viable - which would be expected for those with financial strength ratings in the single-A category - the insurer will enhance the credit quality of the wrapped bond. Importantly, at such a point of stress, it would be expected that the underlying bond rating would be downgraded to a level lower than that of the financial guarantor," it explains.

Fitch's comments follow Moody's recent recognition that US bond insurer financial strength ratings are mostly within the single-A category, thereby moving the agency more in line with its view. The agency indicates that having two of the three major rating agencies taking this position may allow the market to more fully recognise that the core value of bond insurance is the credit enhancement it provides when a wrapped bond comes under stress, as opposed to the historic practice of focusing mainly on the ratings uplift applied to the wrapped bond at the time of issuance.

Most recently, the value of bond insurance has clearly emerged in the examples of Puerto Rico and Detroit. Investors who purchased these issuers' bonds with insurance from a solvent monoline are benefiting from stronger valuations today versus equivalent unwrapped bonds. Insurance can also provide increased market liquidity for issuers and assist smaller or less frequent bond issuers in accessing the market.

Fitch formalised stricter ratings standards for monolines in 2013, recognising that most seasoned US guarantors would typically achieve insurer financial strength (IFS) ratings no higher than the single-A category. The core risks of guarantor business models generally include very high use of operating leverage, a narrow business focus, limited financial flexibility under stress and high sensitivity of their competitive positions to even modest perceived changes in financial strength. To make the assessment of a financial guarantor more consistent with that of other insurers and financial companies, the agency's revised criteria lessened reliance on capital adequacy modelling and placed greater weight on factors other than capital, including financial performance, market positioning and management/governance.

In its recently published request for comment on proposed criteria, Moody's seems to be formalising a position that also points to IFS ratings in the single-A category as typically being the upper limit for most healthy monoline insurers. Other rating agencies, such as S&P and Kroll, still permit bond insurers to reach the upper end of their rating scales (double-A).

Structured Finance

Further capital charge reductions for Solvency 2

Fitch reports that under the latest revisions to Solvency 2, capital charges for type 1 securitisation positions rated double-A, single-A and triple-B will be reduced by 29%, 46% and 41% respectively. The changes appear to be targeted at the issuance of securitisations backed by residential mortgages, consumer loans and particularly SME lending from southern European countries that cannot achieve triple-A ratings and were disproportionately disadvantaged by the previous capital charges.

"The latest revisions will bring little benefit to the largest and most active European securitisation markets, including those for UK and Dutch RMBS and northern European consumer loan ABS, as most of the issuance from those structures is rated triple-A," Fitch suggests.

A previous revision to the framework for securitisation investments had already halved the applicable capital charges across the rating spectrum for high quality securitisations to better reflect the types of securitisations European insurers hold and their typical buy-and-hold strategy. However, the charges may still be considered high by insurers relative to expected losses.

Fitch believes the capital charge for a typical newly issued double-A rated RMBS tranche with a seven-year WAL would be 21%, while the total loss rate on all European prime RMBS with investment grade (excluding triple-A) ratings is only 1.6%.

The charges on non-type 1 positions - which are, in some cases, up to 100% - have not been reduced and appear designed to deter insurers from investing in those tranches. Securitisations that do not qualify for the higher quality definition include those backed by commercial real estate loans and non-conforming, self-certified or high loan-to-value ratio residential loans.

Insurers can use an internal capital model to reduce the charges on their assets. However, Fitch says that regulators are likely to limit such reductions for securitisation assets, given their caution about the associated risks.

The agency adds that investor confidence is key to the successful operation of European securitisation markets. Capital charge requirements that are not excessive relative to other forms of investment and that are stable over time will be important in establishing investor confidence in securitisation markets.

The latest Solvency 2 proposals are expected to be published by end-September and come into effect on 1 January 2016, although transitional measures mean that the rules may not take full effect until 2032.

Structured Finance

Servicing 'hubs' identified

The top seven cities for US commercial servicing operations are Kansas City, Charlotte, Dallas, Miami, Washington, New York and Hyderabad (India), according to S&P. The findings are based on data from the agency's ranked commercial mortgage loan servicers, pinpointing major geographic locations for commercial mortgage servicing.

"We believe Hyderabad is the newest servicing hub," S&P notes. "It represents a key site for off-shoring for a wide base of business lines of financial services firms, and is not restricted to commercial and residential mortgage servicing. Factors contributing to the off-shoring trend include the lower cost of labour and a large, well-educated and motivated workforce [see also SCI 26 June 2013]."

Each of the top seven cities has a large presence of servicers or a key effect on the industry, the agency says. For example, aside from the large presence of commercial mortgage servicer operations there, the prominent role of the federal government, its important role in the mortgage market and the presence of Fannie Mae and Freddie Mac make Washington a key city for both residential and commercial mortgage servicers.

"While many commercial mortgage servicers are not located in the top cities for servicing, given the industry's historical move towards consolidation, we believe all servicers and securitisation participants should understand the role of these hubs," S&P concludes.

Structured Finance

Valuations handbook released

Voltaire Advisors has published its 2014 Valuation Risk Handbook, which aims to provide a true 'state of the nation' picture of the current valuations of financial assets landscape. The report covers ongoing developments in the regulatory and standards fields, including global valuations standards efforts, the fair value pricing of US mutual funds and the implications for valuation of the AIFMD and IFRS.

The Handbook also includes the results of a wide-ranging global survey of valuations users. During May, Voltaire polled 220 users of valuation on the practical problems of meeting their external and internal valuation obligations. The results are surprising and appear to challenge some of the received wisdom enshrined in regulator advice.

Ian Blance, md of Voltaire Advisors, comments: "The Valuation Risk Handbook aims to present, in one easily accessible publication, a clear and comprehensive review of the key issues currently facing firms involved in the ongoing valuation of financial instruments, and the sources of pricing, data, models and advice available to them to assist their efforts."

Structured Finance

Greek sovereign ceiling lifted

Moody's has upgraded 20 tranches, affirmed one and placed another on watch for upgrade across nine Greek structured finance transactions. The move follows the raising of Greece's country ceiling to Ba3 from B3 and its sovereign rating to Caa1 from Caa3. The agency has also reassessed collateral performance and revised portfolio assumptions in three transactions.

Moody's notes that the raising of Greece's country ceiling to Ba3 reflects the improvement in the country's economic outlook, the significant improvement in its fiscal position over the past year and the government's reduced interest burden and lengthened maturities of the debt. The highest rating for outstanding Greek structured finance securities is now Ba3, up from B3.

CDO

SCDO counterparty criteria released

S&P has released criteria for assessing counterparty risk in terminating synthetic CDO and credit-linked note transactions, including risks associated with the bankruptcy of the counterparty. The criteria align the rating levels at which the counterparty commits to begin posting under terminating transactions with the minimum eligible counterparty ratings established in the agency's counterparty risk criteria.

Terminating transactions are structured such that, in case of an early termination due to the swap counterparty's default, all available assets can be liquidated and used to repay principal and interest due to the noteholders. The assets available to repay the noteholders consist of collateral purchased with the notes' initial sale proceeds and any other collateral that the swap counterparty posts to mitigate its credit risk.

The minimum eligible counterparty ratings - the ratings below which counterparties post counterparty-posted collateral - will determine the maximum potential rating that the terminating transaction can achieve, S&P notes. The maximum potential rating will also depend on the nature of the counterparty exposure.

CDO

Trups CDO cures continue

The number of US bank Trups CDO combined defaults and deferrals decreased to 22.7% at end-July, compared with 22.9% at end-June, according to Fitch's latest index results for the sector. In July, seven banks deferring interest on a total notional of US$65.6m across 14 CDOs cured. Of these banks, three - representing US$26.5m in notional - were due to reach the end of the maximum allowable five-year deferral period in 2014.

One issuer representing US$5m in collateral deferred interest on its Trups in July. There were no new defaults during the month, but a defaulted issuer with total notional of US$15m across two CDOs has been sold out of the portfolios at an 8% recovery.

Across 78 Fitch-rated Trups CDOs, 231 bank defaulted issuers remain in the portfolio, representing approximately US$6.3bn of collateral. Additionally, 197 issuers are currently deferring interest payments on US$2.3bn of collateral.

CDS

Solocal CDS settled

The final price for Solocal Group (formerly known as PagesJaunes Group) LCDS was determined to be 88.5 at yesterday's auction (SCI 21 July). Three dealers submitted initial markets, physical settlement requests and limit orders to settle trades across the market referencing the name.

Separately, ISDA's Americas Determinations Committee has delayed the Argentine Republic CDS auction until after the US Labor Day holiday (SCI 14 August), following a challenge it received in respect of two bonds included on the supplemental list (ISINs ARARGE03E667 and ARARGE03E659). The final list of deliverable obligations for the auction will not be published until this challenge has been resolved by the DC.

CDS

Argentine CDS auction scheduled

An auction to settle Argentine Republic senior CDS trades has been scheduled for 21 August, following ISDA's determination of a failure to pay credit event (SCI 4 August). The initial list of deliverable obligations consists of 11 bonds. The Americas Determinations Committee notes that it is aware of four additional bonds issued by the Argentine Republic, but it has been unable to obtain documentation for them.

CDS

US Steel CDS tighter on cost cutting

Credit default swap (CDS) spreads on United States Steel Corporation have tightened to levels not seen since 2010, according to Fitch Solutions in its latest CDS case study. Five-year CDS on US Steel tightened by 29% over the past month.

Credit protection on US Steel's debt is pricing 56% lower compared to a year ago - the tightest levels seen since April 2010. After pricing consistently in line with single-B minus levels, CDS on US Steel are now trading one notch higher.

"US Steel's boost in market sentiment is likely due to better-than-expected second-quarter results and its successful cost cutting programme," comments Fitch director Diana Allmendinger.

CLOs

Additional issuance for Euro CLO 2.0

Dryden XXVII Euro CLO 2013 subordinated noteholders have approved the creation and issuance of additional notes via a written resolution, at the request of the issuer. The move follows the replacement of PIM Foreign Investments as risk retention holder on the transaction with the collateral manager Pramerica Investment Management.

The issuer notified noteholders on 13 August that it wishes to issue further notes of each class, having an aggregate principal amount of between €150m and €225m, during an issuance period of between 29 September and 30 October. The additional notes will have the same terms and conditions as the existing classes of notes and shall be consolidated with them to form a single series.

Although in this case additional notes across all classes will be issued, Bank of America Merrill Lynch CLO analysts note that the deal also allows for the issuance of further subordinated notes, subject to a number of conditions. Proceeds from the new issuance may be used to invest in further assets.

CMBS

Second 2.0 loan liquidated

The US$6.2m Langtree Ventures Portfolio loan - securitised in GSMS 2013-GCJ14 - has been resolved with a 1% loss severity, becoming the second-ever CMBS 2.0 loan to liquidate. Morgan Stanley CMBS strategists note that the payment distribution was consistent with their understanding of the CMBS 2.0 waterfall, in contrast to the first 2.0 liquidation - The Cove at Southern, securitised in JPMCC 2011-C5 - which resulted in a surprising interest shortfall reimbursement to the class NR notes (see SCI's CMBS loan events database). The master servicer subsequently corrected the error.

The Langtree Ventures Portfolio loan was transferred to special servicing in March due to imminent default, with the mezzanine lender remitting a partial payment of the amount necessary to cure the default in May. The sponsor reports that several tenants are behind on rent.

US$6.4m of net proceeds was received upon liquidation, equating to 57.7% of the appraised value. US$6.1m, together with another US$1.2m of scheduled principal, was applied to the class A1 notes. The class H notes realised a US$64,000 loss.

CMBS

CMBS 2.0 loan prepays

The US$19.5m Acropolis Gardens Realty Corp loan, securitised in WFRBS 2013-C15, has paid off with a prepayment penalty (see SCI's CMBS loan events database). The building is a multifamily property in Queens, New York, that consists of condominium and cooperative units dependent on maintenance payments to pay debt service.

This led to a low underwritten LTV of 14.1%, but unclear operating cashflows, according to Barclays Capital CMBS analysts. The loan was underwritten to a US$4.9m NOI, but this was based on a valuation as if the property were a standard rental building. The loan was further complicated by a 'wrap mortgage' that comprised the securitised loan plus a US$1m equity note.

The loan became delinquent in January, just six months after origination. The property is believed to be subject to litigation, claiming fraud and breach of fiduciary duty on the part of the cooperative and borrower.

The liquidation of the loan, likely from a borrower pay-off, repaid the outstanding balance minus a 1% loss due to special servicing fees. A US$1.5m prepayment penalty was incurred, which is lower than the estimated US$3.1m total yield maintenance penalty due.

The prepayment paid off 39% of the front-cashflow A1 bond and the 1% loss was applied to the unrated G tranche. The prepayment penalties were applied entirely to the XA IO tranche.

CMBS

CMBS resolutions hit lows

US CMBS delinquencies were unchanged in July at 4.87%, bringing an end to 15 consecutive months of declines in which the rate dropped by 276bp from 7.63%, according to Fitch's latest index results for the sector. Resolutions of US$462m and new delinquencies of US$398m last month marked post-recession lows, with the overall rate unchanged due to a decrease in the index denominator. Fitch-rated new issuance volume of US$3.8bn failed to keep pace with US$5.9bn in portfolio run-off.

Resolutions in July were led by the US$36.7m Cornerstone Commerce Center loan (securitised in CSMC 2007-C5), which was disposed of for a 41% loss (see SCI's CMBS loan events database). Meanwhile, the largest new delinquency was the US$31.4m BB&T Tower (JPMCC 2007-LDP12), which failed to pay off at its 9 July maturity.

Delinquency performance for the major property types was mixed last month. Industrial improved the most (by 51bp), thanks to strong resolution volume. Conversely, hotel worsened by the largest margin (17bp), fuelled by a sharp reduction in its denominator from loan pay-offs. The other major property types saw changes of less than 10bp.

Current and previous delinquency rates are: 5.56% for Multifamily (from 5.65% in June); 5.47% for hotel (from 5.30%); 5.27% for industrial (from 5.78%); 5.22% for office (from 5.13%); and 4.85% for retail (from 4.82%).

Fitch suggests that CMBS delinquencies could fall by at least another 10bp in the months ahead as properties listed on Auction.com are sold (SCI 4 August), including US$415m of assets in Fitch-rated deals. The overwhelming majority of the assets are securitised in two transactions: COMM 2006-C8 (accounting for US$170m) and MLCFC 2007-9 (US$165m). The largest by stated balance - both in MLCFC 2007-9 - are: US$79m DLJ West Coast Hotel Portfolio and US$50m St. Louis Flex Office Portfolio.

Insurance-linked securities

Cat bonds affirmed on annual resets

S&P has affirmed its ratings on five natural-peril catastrophe bonds issued by three different issuers, which had annual resets of the probability of attachment. The affected tranches are: Compass Re Series 2011-I classes 1, 2 and 3; Embarcadero Re Series 2012-II class A; and Northshore Re Series 2013-I class A.

In each case, the probability of attachment was reset to a percentage consistent with the transaction documents and the current rating, S&P says. In addition, the agency reviewed the creditworthiness of each ceding company and the ratings on the collateral that - barring the occurrence of a covered event - will be used to redeem the principal on the redemption date.

RMBS

Risk-transfer trigger test breached

CAS 2014-C01 subordinate bonds are expected to be locked out from unscheduled principal for the August remittance, after five loans were removed from the pool last month. The development is not believed to be a cause for concern, however.

The five loans turned 180-days delinquent last month, resulting in a credit event and their subsequent removal from the pool. This left the senior subordination at 2.99976%, just below the 3% threshold required for the subordinate bonds to receive unscheduled principal payments, according to RMBS analysts at Bank of America Merrill Lynch. They nevertheless expect the resulting deleveraging of the deal to push the senior subordination back above the threshold, which would then allow unscheduled principal to be paid to the sub notes for the September remittance.

Three of the loans were assigned risk scores of above 100, indicating a higher probability of default. The BAML analysts note, for example, that the DTI for each of the three loans was around 43%-44%. Two of these loans were layered with either a lower FICO or high combined LTV, while the other's risk score was primarily driven by its occupancy type as an investor property.

However, the other two loans that experienced a credit event had risk scores in the mid-50s, indicating a low probability of risk. Their FICO scores were each upwards of 780, so LTV and DTI ratios may have driven the delinquencies.

The analysts compare loans that are 90+ days delinquent in CAS 2014-C01 with the aggregate of loans that are 90+ days delinquent across all risk-transfer RMBS. The risk score for the first group is 139 versus 74 for all loans, indicating that the delinquent loans were riskier and more likely to default.

The analysts find that 80% of all risk-transfer loans have a risk score under 100. Comparing the loans that are 90+ delinquent to the total CRT outstanding, factors contributing to the higher risk appear to be a greater percentage of cash-out refinancings (39% versus 16%) and a lower FICO score (720 versus 761). In addition, the average DTI for the 90+ loans was higher at 36% versus 33% for the universe, while 17% of the 90+ loans had DTIs greater than 45% compared to only 7% for all the CRT loans.

"We expect the senior/subordination trigger test to fail from time to time in CRT deals and we do not think that one isolated failed test is cause for concern," the analysts conclude. "Additionally, a failed trigger test results in unscheduled principal payments being redirected to the senior; scheduled principal and interest continue to be paid as agreed upon. The subordination of the investable CRT tranches is sufficient to cover expected net losses to the bonds and is comparable to investment grade ratings of jumbo RMBS."

RMBS

RFC issued on LMI assessment

S&P is requesting comments on its proposed revision of the methodology for assessing lenders' mortgage insurance (LMI) as a form of credit enhancement in global RMBS, global covered bonds and debt ratings in the US municipal housing sector. The proposal takes into consideration the recent experience of mortgage insurance pay-out adjustments in certain markets under stressful economic conditions.

In determining the amount of credit applied to LMI as a form of credit enhancement in the rating analysis of rated securities, the proposed criteria consider the stated coverage of the LMI policy, an insurer's capacity to pay and the estimated claims pay-out ratio. For a pool of assets that are well-diversified across a large number of loans, it is more likely that individual obligor defaults will occur at different points in time before the LMI provider exhausts its capacity to pay - thus increasing the likelihood of honoured claims under the LMI policy, even under stress scenarios greater than reflected by the LMI provider's issuer credit rating.

The rating impact of the proposal is expected to be concentrated in Australia, where 100% LMI is a material form of credit enhancement in rated RMBS and the current ratings on lenders' mortgage insurers are in the double-A category. The rating impact will mainly be driven by the proposed changes to claims-adjustment assessment and will predominately affect the subordinated tranches in Australian RMBS, for which LMI is in many cases the only source of hard credit support. S&P notes that yield and cashflow analysis will determine the magnitude of any rating change on these tranches.

Comments on the proposal are invited by 30 September.

RMBS

RFC issued on RMBS update

Moody's is requesting feedback on a proposed update to its approach to rating US prime RMBS. A new version of the MILAN model will be the main quantitative tool for the agency's collateral analysis under the proposal.

Based on an extensive analysis of performance data and incorporating leading-edge statistical methods, Moody's says the new model supports a robust analysis of US RMBS that is also consistent with its global approach for RMBS. The proposed changes also bring greater transparency, providing market participants with specific details about the development and application of the rating agency's models for loan and pool level default risk and loss given default.

"The US MILAN model is conceptually similar to the global MILAN model we generally use to assess collateral in RMBS transactions globally," says Moody's md Navneet Agarwal. "We also believe it sets a new standard for transparency by providing a quantitative tool that market participants can use to estimate Moody's initial calculation of Aaa stress loss for a given mortgage portfolio."

The rating agency has adopted a 'competing risk' modelling framework, which models both default and prepayments simultaneously. The model includes a number of novel features, such as time-varying sensitivities with respect to FICO, CLTV and spread at origination. It also incorporates default and prepayment behaviour as functions of the forward 12 months of house price appreciation.

Under the proposal, the agency will also evaluate the quality of data and the alignment of incentives for a transaction through a thorough assessment of the originator, an analysis of an independent third-party review of the data quality and an evaluation of the representations and warranties. In addition, it consolidates a number of published methodology documents on representations and warranties and independent third-party reviews.

The proposed methodology will apply to the rating and monitoring of US RMBS backed by first-lien prime mortgage loans issued beginning in 2010. For seasoned transactions rated before January 2010, for which significant performance information is available and which have been exposed to severe declines in home prices and increases in unemployment, Moody's will continue to use its US RMBS surveillance methodology.

The agency does not expect the proposed updates, if adopted, to result in any changes to outstanding ratings. Feedback on the proposal is invited by 14 October.

RMBS

RFC issued on servicer advance approach

S&P is requesting comments on proposed changes to the methodology and assumptions it uses to rate US servicer advance securitisations. The criteria revisions aim to promote comparability in ratings across all sectors of the RMBS market.

The proposed criteria would involve modifying the reimbursement curves between the single-B and triple-A rating categories to factor in changes to S&P's outlook in this sector. For high-investment grade servicers, the agency would adjust the standard reimbursement curves to reflect the greater likelihood of a servicer's continued operation during stressed scenarios.

The revisions would also incorporate S&P's event risk assumption, which contemplates the potential for cashflows to be disrupted due to event risk (such as foreclosure moratoriums) and the timing of advance reimbursements for different advance types - including P&I pool-level, P&I judicial and non-judicial, and non-P&I judicial and non-judicial - under different rating scenarios. Assumptions regarding timing of recoveries and interest rates will be used to calculate the applicable advance rates per rating category. In addition, the criteria would establish 'standard' reimbursement curves, along with 'above standard' and 'below standard' ones for different advance types and rating scenarios.

S&P's impact analysis does not consider any additional interest rate sensitivity testing or potential rating caps imposed by the minimum reserve fund requirements. Out of approximately half of the outstanding servicer advance security ratings, the agency expects that nearly 30% could be lowered and less than 20% could be raised.

Comments are invited on the proposed criteria by 28 August.